Yuan Tumbles To 11-Month Lows As China Home Price Growth Slows

It would appear that the widening of the daily trading bands (we discussed last night) are having a directional effect on USDCNY as the devaluation continues on the back of forced carry-trade unwinds. At 6.19, CNY is its weakest in 11 months (2.5% weaker than its lows in January) and the last 2 months have seen by far the biggest weakening in the currency on record. This 'implied' easing is modestly supporting the stock market and copper for now (though we suspect that is more spillover from risk-on squeezes post-Ukraine). While Goldman and BofA are adamant that widening the bands will not mean a change in trend overall, it seems clear that hot money is outflowing and driving a trend change anyway ascorporate bond prices are not rising and home-price appreciation is slowing in the major cities.

China's decision to squeeze speculators out of its currency is causing pain for local companies and individual investors.

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China is attempting to reduce the amount of money flowing into the country from foreign investors looking to profit on a rise in the yuan. The government sees this cash as inflating asset prices and making the economy more vulnerable to financial shocks.

But the currency's decline is having a broader impact, particularly on Chinese companies that had placed bets on an appreciating yuan, traders and analysts say.

These companies have placed such bets in recent years to guarantee steady revenue from exports as the currency's value climbed steadily against the dollar.

Many companies borrow money to make these trades, magnifying gains when the yuan rises but opening them up to big losses if the currency falls.

With the yuan down 2% against the dollar this year, more of the bets are losing money, said Geoff Kendrick, head of Asian currencies and rates at Morgan Stanley.

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He estimates that paper losses on one popular way companies hedge their yuan exposure and individual investors bet on the yuan, through what is known as target redemption-forward products, have hit $2.3 billion, on contracts valued at $150 billion.

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"In the past, when the [yuan] had a clear one-way trend, it used to be really easy for corporates. But now, with two-way volatility it becomes very tricky for them to manage," he said. "It's going to be a very different market from here."

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For now, most of the losses remain on paper because investors and companies haven't yet sold their positions. However, banks are asking both corporate and individual clients with losing bets to pony up more collateral, traders in Hong Kong say. Banks also are advising companies to restructure their investments around weaker levels for the yuan, a cheaper alternative than completely unwinding millions of dollars of the products, which were originally designed to help companies hedge against gains in the yuan.

While the recent declines likely aren't big enough to trigger a stampede out of the yuan, the added volatility in the exchange rate may give some investors pause.

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"If the currency appreciation is no slam dunk anymore…part of the attraction of owning Chinese equities and bonds is being erased," said Greg Anderson, global head of foreign-exchange strategy for BMO Capital Markets, a subsidiary of BMO Financial Group. "The result will probably be less foreign portfolio investment in China."

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"Some hedge funds are closing up positions,"... Even a small drop in the yuan could trigger big losses. Many investors are vulnerable if the yuan weakens to 6.20 to the dollar

And with home price appreciation slowing, perhaps things are moving a little too fast for the PBOC to manage?

As we warned before, Simply put, if the CNY keeps going (whether by PBOC hand or a break of the virtuous cycle above), then things get ugly fast...

How Much Is at Stake?In their previous note, MS estimated that US$350 billion of TRF have been sold since the beginning of 2013. When we dig deeper, we think it is reasonable to assume that most of what was sold in 2013 has been knocked out (at the lower knock-outs), given the price action seen in 2013.

Given that, and given what business we’ve done in 2014 calendar year to date, we think a reasonable estimate is that US$150 billion of product remains.

[16]

Taking that as a base case, we can then estimate the size of potential losses to holders of these products if USD/CNH keeps trading higher.

In round numbers, we estimate that for every 0.1 move in USD/CNH above the average EKI (which we have assumed here is 6.20), corporates will lose US$200 million a month. The real pain comes if USD/CNH stays above this level, as these losses will accrue every month until the contract expires.Given contracts are 24 months in tenor, this implies around US$4.8 billion in total losses for every 0.1 above the average EKI.

As Morgan Stanley warns however, this has much broader implications for China...

The potential for US$4.8 billion in losses for every 0.1 above the average EKI could have significant implications for corporate China in its own right, as could the need to post collateral on positions even if the EKI level is not breached.

However, the real concern for corporate China is linked to broader credit issues. On that, it’s worth reiterating that the corporate sector in China is the most leveraged in the world. Further loss due to structured products would add further stress to corporates and potentially some of those might get funding from the shadow banking sector. Investment loss would weaken their balance sheets further and increase repayment risk of their debt.

In this regard, it would potentially cause investors to become more concerned about trust products if any of these corporates get involved in borrowing through trust products. In this regard, this would raise concerns among investors, given that there is already significant risk of credit defaults to happen in 2014.

Remember, as we noted previously, these potential losses are pure levered derivative losses... not some "well we are losing so let's greatly rotate this bet to US equities" which means it has a real tightening impact on both collateral and liquidity around the world... yet again, as we noted previously, it appears the PBOC is trying to break the world's most profitable and easy carry trade - which has created a massive real estate bubble in their nation (and that will have consequences).

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The bottom line is the question of whether the PBOC's engineering this CNY weakness is merely a strategy to increase volatility and thus deter carry-trade malevolence (in line with reform policies to tamp down bubbles) OR is it a more aggressive entry into the currency wars as China focuses on its trade (exports) and keeping the dream alive? (Or, one more thing, the former morphs into the latter as a vicious unwind ensues OR the market tests the PBOC's willingness to break their momentum spirit).

"Putin Did The Right Thing" Says Marc Faber, But Fears China Implications More

While Marc Faber is adamant that "there’s lots of funny things that are happening in China. And when the whole thing unwinds it will be a disaster," it is his comments with regard Ukraine (and Russia) that are worth paying significant new attention to. As The Gloom, Boom & Doom Report editor notes in this brief Bloomberg TV interview, if you put yourself in Putin's shoes "he did the right thing from his perspective," given Crimea's strategic importance. However, as Faber concludes, "Crimea moving to Russia gives essentially a signal to China that one day they can also move and seize some territory that they perceive belongs to them."

Faber On Russia, Ukraine and its signaling to China...

Mr. Putin did the right thing from his perspective. We have to look – put ourselves into his shoes. He did absolutely the right thing at the right time.

...By that I mean that there was interference by foreign powers in Ukrainian politics that were unfavorably from the perspective of Russia.

...The Crimea is strategically most important for Russia. It has practically no meaning strategically to the United States or to Europe. But for Russia it’s very important. I don’t think that Russia will move further into Ukraine unless there is serious provocation. But I doubt it will happen. But I think the wider implication is that we have now border lines. In other words, the US would intervene if a foreign power would establish bases in Haiti and in Cuba and so forth and so on, and the Chinese will react if foreign powers threaten Chinese access to resources.

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This is very important because the occupation or say the referendum (ph) in Crimea andCrimea moving to Russia gives essentially a signal to China that one day they can also move and seize some territory that they perceive that belongs to them.

Faber confirms his perspective on China...

...we had a colossal credit bubble in China and that this credit bubble is now being gradually deflated and will bring about problems in the real estate market and among some major players in the commodity markets as well. So overall, if I look at export figures from China, and they are very closely correlated to overall economic growth, then there is a huge discrepancy between what China reports and what China’s trading partners are reporting.

So if you look at the figures of China, exports are still growing. If you look at the trade figures China exports to Taiwan, so China records exports of so and so much. The Taiwan report imports from China at a much lower level. So which figures are more reliable? I think the figures of the trading partners of China are more reliable. And they would suggest that growth has slown down considerably.

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Governments will always publish the statistics that they wish to show irrespective whether that is in China or in other countries. Governments control basically the statistical offices, so they can show whatever they want. As Stalin said, it’s not important who votes but who counts the votes. And the government counts the statistics.

...the fact is simply that Chinese stocks have been just about the worst performing stocks since 2006. Now analysts will dismiss that and say everything is prefect in China, but the stock market does not seem to believe everything that the government is saying about the economy. And clearly there are strength signs in the Chinese economy. In particular, as I said, we have this huge explosion of debt. Debt as a percent of GDP has increased in the last five years by more than 50 percent. Total debt is now over 215 percent of GDP, and a lot of it is trade finance that is being rolled over.

In addition to that, there are lots of funny deals. A friend of mine who analyzes China very carefully, Simon Hunt (ph), he pointed out that trade finance between one state-owned enterprise and a private company has amounted to over $5 trillion by continuing to roll over the same collateral several times. There’s lots of funny things that are happening in China.And when the whole thing unwinds it will be a disaster.

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I think that investors are not sufficiently aware that the Chinese economy is far more important for other emerging economies than the United States because China is a large importer of resources. In other words, iron ore, copper, zinc (inaudible). And at the same time, they are a huge exporter to commodity producers of their own manufactured goods, as well as Korean exports. The commodity producers are much larger than Korean exports to the US or to the U (ph).

So if the Chinese economy slows down, commodity prices – industrial commodity prices are likely to remain under pressure.They already come down a lot. They remain under pressure and the resource producers have less money. In other words, the Brazilian goes into recession. The Middle East does not grow as much as before. Central Asia, Africa and so forth all contract, and then they buy less from China and you have a vicious cycle on the downside.

SHANGHAI -- The Shanghai Gold Exchange is poised to get the jump on other mainland equity and commodity trading bourses by launching a gold trading platform in the city's free-trade zone open to foreign investors.

Rules on the gold exchange's "international board" are being reviewed by the central bank and the foreign exchange regulator, and an imminent approval is expected, according to exchange officials.

The platform, likely to get under way in the second half of this year, will mark a major breakthrough in the development of the free-trade zone, the mainland's first free port.

The trading platform and the warehouse will be run separately from the existing trading system in Shanghai's downtown Huangpu district, and the products will be denominated in yuan, part of Beijing's efforts to internationalise the currency.

Spot and forward gold trading will be conducted on the "international board" as analysts foresee a keen interest from foreign traders.

Foreign players will be invited to conduct gold trading, with liberalisation in the sector seen as creating arbitrage opportunities for them.

"Gold will be an ideal trading product to spearhead the efforts to internationalise all kinds of exchanges in the free-trade zone," said Jiang Shu, a gold analyst at Industrial Bank. "The precious metal could trigger a large turnover when the international players come."

Jiang, who has seen the draft rule, said domestic individual investors would not be allowed access to the platform initially.

The central bank and the foreign exchange regulator were expected to grant an investment quota to overseas players for gold trading in the zone, he added.

The Shanghai Gold Exchange will soon register a subsidiary, International Gold Trade Centre, in the trade zone to operate the new trading system.

Foreign institutions and individuals could open accounts in the zone that are designated for gold trading.

China became the world's largest gold consumer last year, overtaking India, after large falls in global prices prompted bargain hunting across the country.

The country produced 428.1 tonnes of gold last year, remaining the top gold producer for a seventh consecutive year.

Shanghai launched the free-trade zone in September last year under Premier Li Keqiang's plans to use the 28.78-square-kilometre territory as a test bed for further economic reforms.

Beijing has promised to make the yuan convertible under the capital account in the zone but has yet to give the go-ahead on this step to institutions and individuals based in the zone.

A liberalised capital account could let foreign investors trade yuan-denominated equities, financial futures and commodity futures - all of which are now off-limits to them. But financial regulators remain concerned over the prospect of a surge in hot money inflows prompted by a fully convertible yuan.

The Shanghai Futures Exchange set up a 5 billion yuan (HK$6.3 billion) subsidiary, Shanghai International Energy Exchange, in the free-trade zone in November last year. Yuan-denominated crude oil futures will be traded on the exchange.

Foreign investors will be allowed to participate in crude oil futures trading as the mainland strives to gain pricing power on the key energy product.

But sources said it would be some time before the regulators finalised a detailed trading framework.

Two from Koos Jansen.....

New York Federal Reserve Lying About Gold Storage

There is about 6700 metric tonnes of gold stored 80 feet below street level on the bedrock of Manhattan, in the vaults of the New York Federal Reserve. None of this gold is owned by the New York Federal reserve, they are merely the custodians for the US treasury (that holds approximately 400 metic tonnes in NY), 60 sovereign countries and the IMF; completely free of charge! From the NY Fed website:

The New York Fed charges account holders a handling fee for gold transactions, including when gold enters or leaves the vault or ownership transfers (moves between compartments), but otherwise does not charge fees for gold storage.

What would be the NY Fed’s incentive to provide this free service? My local gold storing company charges me more than 1 % per annum for the safekeeping of my bullion (lucky me gold is dirt cheap at the moment). If we subtract the 400 metric tonnes, which the NY Fed stores for the US treasury, from the 6700 it stores in total, the outcome is 6300 metric tonnes. At current market value 1 % of 6300 metric tonnes is more than $2.5 billion. How kind the NY Fed does not charge its depositors.

All bars brought into the vault for deposit are carefully weighed, and the refiner and fineness (purity) markings on the bars are inspected to ensure they agree with the depositor instructions and recorded in the New York Fed’s records. This step is vital because the New York Fed returns the exact bars deposited by the account holder upon withdrawal—gold deposits are not considered fungible.

This simply can’t be true. For one, the Bundesbank succeeded to repatriate 5 mt from the NY Fed in 2013 (although they wanted to withdraw 37.5 mt that year to repatriate 300 mt before 2020). Did they get back the exact same bars they once deposited? No, the bars were remelted. This is only logic as we know New York has a big gold leasing market which is largely facilitated by gold from the NY Fed vaults. No, gold leasing is not a conspiracy, it’s just part of the gold market.

The Netherlands have 300 mt of gold stored in New York. The Dutch gold is managed by De Nederlandse Bank (DNB, The Dutch Central Bank). Senior policy maker financial markets at DNB Jan Lamers wrote an essay in 2006 named “Gold Policy Of The Dutch Central Bank“. I translated a few snippets that shine a bright light on central bank gold leasing:

From the beginning of the eighties of the last century there has been a gold leasing market of some size. DNB also participated in it. Because gold leasing is often seen as something magical, I will explain that this is just a normal activity that is part of responsible management of the official gold reserves.

…The lease market made it possible for central banks to lend gold with interest. In a gold loan the gold is physically delivered to the counter-party, the lender gets a claim denominated in gold on the counter-party. When DNB therefore lends 1000 kilograms, it gets a claim of 1000 kilograms of gold on the counter-party. When the loan is repaid the gold bars that are returned are not the same as the ones loaned out, but they meet the same quality standards.Such a transaction is similar to the lending of € 1000 in the form of banknotes. …The debt does not have to be paid back with the same notes, as long as the banknotes are legal tender. If we look at it this this way there is really nothing magical about a gold loan.

…In the eighties of the last century gold producers were looking for a tool to to secure revenues from future mining production and bring down high interest rates for borrowing money. Moreover, it was difficult to attract equity capital to finance mining. As a solution was to borrow gold on a large scale from specialized banks, who in turn borrowed gold from central banks. The borrowed gold was sold in the spot market and with the proceeds the miners financed the production of gold. In later years the mining output could pay of the gold loan. This process serviced mines relatively cheap financing and also they covered the price risks.

…The supply of gold loans is mainly from central banks around the world, only a fraction is being supplied by private gold owners.

Although I’m not sure every gold lease requires a movement of physical gold, the statement from the NY Fed they grant to return the exact same bars deposited by the account holder upon withdrawal, is untenable. As we have have clearly seen by the repatriation of some German gold from the NY Fed.

Written by Koos Jansen on March 16, 2014 at 5:13 pm.....

Week 10, SGE withdrawals 36 MT, 454 MT YTD

The price of gold is rising, but is this purely because of the tensions in the Ukraine? Not entirely, I think it adds fuel to a supply shortage created by enormous Chinese physical demand since April 2013. While paper sentiment might change today or tomorrow, the physical reality will eventually be the main driver to push the pice upwards.

Throughout history gold has always been the most constant form of money. In 1900 you could buy roughly the same amount of breads with one gram of gold as two thousand years ago. There has been no other currency that is equally constant. But the value of gold has been in for a ride since 1971, when Nixon ended the gold exchange standard in order to maximize the national benefit of issuing the world reserve currency for the US. US’ policy was to remove gold from the international monetary system, from that moment the international monetary system was debt based. To make believe the dollar was stronger than gold in the foreign exchange markets the price of gold had to be suppressed. Controlling CPI would do the rest.

In 1971 the minimum wage in the US was $1.60 per hour, the price of gold was $40.62 per ounce. This meant it took 25.4 hours of labour to earn 1 ounce of gold. In 2014 the minimum wage is $7.25 and the price of gold is $1350. Now it takes 186 hours to earn 1 ounce of gold. Keynesians would say; so what, gold is useless. I would say it’s not useless, in fact for thousands of years it proved best suitable as stable money (next to its exceptional properties as a metal).

But let’s have a look at something we can eat: a loaf of bread. In 1971 the average price of one loaf of bread was $0.25, or 0.16 hours of labour. In 2014, even with automation and scaling, one loaf of bread costs $2, or 0.28 hours of labour. It now takes more labour to earn a loaf of bread; labour has devalued.

By abandoning the gold standard the debt/inflation spiral has widened the gap between the rich and poor, wiping out the purchasing power of the middle class. Perpetual inflation, caused by printing money, drives all wealth to the top. The ones that can spent newly printed money first, in a market where prices are not yet influenced by the new money, have an advantage over the ones that can spent this money last, in a market where prices have been bid upwards.

30 years ago the income of a Dutch bus driver could buy him a house, let his wife raise two kids and go on a holiday once a year. Those days are long gone…

Just some thoughts, maybe shared by some Chinese as they buy physical gold as much as can be supplied.

Overview Shanghai Gold Exchange data 2014 week 10

- 36 metric tonnes withdrawn in week 9 (03-03-2014/07-03-2014)

- w/w – 26.12 %

- 454 metric tonnes withdrawn year to date

My research indicates that SGE withdrawals equals Chinese wholesale gold demand. For more information read this, this, this and this.

This is a screen shot from the weekly Chinese SGE trade report; the second number from the left (blue – 本周交割量) is weekly gold withdrawn from the vaults in Kg, the second number from the right (green – 累计交割量) is the total YTD.

This chart shows SGE gold premiums based on data from the SGE weekly reports (it’s the difference between the SGE gold price in yuan and the international gold price in yuan).

Below is a screen shot of the premium section of the SGE weekly report; the first column is the date, the third is the international gold price in yuan, the fourth is the SGE price in yuan, and the last is the difference.